## 1. Romania’s Recent Anticorruption Campaign

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### Background and governance
- Romania made important progress in addressing economic imbalances and restoring growth after the global financial crisis through prudent policies and Fund-supported programs.
- Per capita income has surpassed pre-crisis levels and growth is projected to be amongst the highest in the region in the near term.
- Governance problems received more attention recently; Romania has been recognized for progress in the fight against corruption and the anticorruption agency has high public opinion ratings.
- Romania’s position in perception of corruption indicators produced by Transparency International and the World Bank has improved in recent years.

### Recent economic developments
- Growth dynamics
  - The economy is on a cyclical upswing supported by strong domestic demand driven mainly by private consumption and recent hikes in minimum and public wages.
  - Investment showed signs of pickup partly related to catch-up in EU funds absorption and helped offset a weakening of exports in the second half of the year.
- Inflation and wages
  - Annual headline inflation turned negative in June 2015 following a reduction in VAT on food items from 24 to 9 percent.
  - Adjusting for VAT changes, underlying inflation has remained positive and been rising.
  - Overall wages grew by 11.6 percent (y/y) in January 2016, reflecting public wage and minimum wage hikes.
  - Minimum wage expected to be raised to 1,250 lei in May 2016 from 1,050 lei (about €265).
  - Unit labor costs increased by 2.2 percent in 2015 and by 7.6 percent since 2010.
- Fiscal outcomes and public debt
  - General government deficit (cash basis) was 1.5 percent of GDP in 2015, compared to 1.8 percent in the original budget.
  - Revenues were 1.3 percent of GDP higher than budgeted in 2015.
  - Total expenditure was 0.9 percent of GDP higher mainly due to personnel spending.
  - Public debt stood at around 40 percent at end-2015.
  - Preliminary data: the budget recorded a surplus of 0.4 percent of GDP in the first quarter compared to 0.7 percent in the same period of 2015; the difference reflects mainly lower VAT revenues.
- External sector and reserves
  - Current account deficit is small and widened modestly in 2015, driven by an increase in the goods trade deficit and an almost doubling of the primary income deficit.
  - Gross reserves of €35.5 billion at end-2015 were broadly adequate by most reserve adequacy metrics.
  - The current account deficit is projected to gradually widen in 2016–17 and reach around 3.5 percent of GDP over the medium term.
- Banking sector and financial stability
  - NPL ratio fell to 14 percent at end-2015 compared to a peak of 22 percent in 2014Q1 (reflecting write-offs and sales).
  - Credit growth: local currency lending growth more than offset continued decline in foreign currency lending.
  - Banking system enjoys comfortable levels of capital adequacy and liquidity; profitability is improving.
  - Exposures and risks: FX mismatches in borrowers’ balance sheets and market risk related to large bond holdings.
  - Four Greek-owned Romanian banks experienced substantial deposit withdrawals last summer; withdrawals have largely been reversed.
  - NBR introduced additional capital buffer requirements: capital conservation buffer, countercyclical capital buffer (currently set at zero), buffer for systemically important institutions, and a systemic risk buffer.

### Outlook and risks
- Staff baseline projections and assumptions
  - Growth expected to remain above potential in 2016–17, with a near-term cyclical acceleration driven mostly by domestic consumption and a strong fiscal impulse, then returning gradually to potential.
  - Underlying inflation expected to gradually pick up.
  - Current account deficit expected to widen on import growth.
  - Baseline assumes authorities will not exceed 3 percent of GDP deficit in ESA terms (2.8 percent of GDP on a cash basis); achieving this would require additional measures.
- Key projections (selected macroeconomic outlook)
  - Real GDP (yoy): 2014 3.0; 2015 3.8; 2016 4.2; 2017 3.6; 2018 3.3
  - CPI inflation (yoy, eop): 2014 0.8; 2015 -0.9; 2016 1.5; 2017 3.4; 2018 2.7
  - Unemployment rate (average): 2014 6.8; 2015 6.8; 2016 6.4; 2017 6.2; 2018 6.3
  - Current account balance: 2014 -0.5; 2015 -1.1; 2016 -1.7; 2017 -2.5; 2018 -2.7
  - Fiscal balance (cash): 2014 -1.9; 2015 -1.5; 2016 -2.8; 2017 -2.8; 2018 -2.8
  - Gross external debt (percent of GDP): 2014 63.1; 2015 56.7; 2016 58.7; 2017 56.6; 2018 52.7
  - Gross general government debt (percent of GDP): 2014 38.7; 2015 38.1; 2016 37.4; 2017 37.0; 2018 38.1
- Risks
  - Downside risks tilted to the downside, mainly related to the pre-electoral environment and external uncertainties.
  - Further fiscal stimulus in an election year may boost consumption short term but undermine sustainability of public finances and market sentiment.
  - Inappropriate measures targeting the financial sector without proper impact analysis and consultation could harm credit intermediation, investment, and financial stability.
  - External risk: abrupt deterioration in emerging market risk perception could trigger currency depreciation and raise the external debt-to-GDP ratio.
  - Mitigation: maintaining adequate reserve levels, exchange rate flexibility, and fiscal buffers will be key.

### Fiscal policy assessment and recommendations
- Recent policy changes and fiscal stance
  - Authorities adopted in late 2015 a package of large tax cuts costing 1.4 percent of GDP in 2016 and a further 0.8 percent of GDP in 2017.
  - Measures include reduction of the standard VAT rate from 24 to 20 percent in 2016 and to 19 percent in 2017, reduction of fuel excises, dividend tax, health contributions and the elimination of the special construction tax.
  - Several expenditure-expanding measures introduced, notably ad-hoc salary increases costing 1½ percent of GDP in gross terms.
  - Staff projects the cash deficit to escalate to 3¼ percent in 2017 under current policies, well above the authorities’ cash deficit target of 2.8 percent of GDP for 2016 and 2017.
  - Even if the authorities’ deficit path is achieved, public debt will exceed 40 percent of GDP and continue to gradually rise over the medium term.
- Staff diagnosis
  - Fiscal policy is pro-cyclical and implies a structural relaxation of 2¼ percent in 2016.
  - The stance is inappropriate from demand management perspective and risks returning Romania to pre-crisis patterns.
  - Public debt tripled between 2008 and 2015, indicating vulnerability and the need for fiscal buffers.
- Staff recommendations and targets
  - Anchor fiscal policy on a well-defined debt-reduction path.
  - Staff recommended gradual adjustment to lower the cash deficit to 1.5 percent of GDP by 2018.
  - Immediate effort: find and preserve savings to keep the deficit below 2.5 percent of GDP in 2016.
  - For 2017, staff recommended a deficit of 2 percent of GDP.
  - Suggested measure: postpone further tax reductions on VAT and excises scheduled for next year until offsetting measures are identified—this would generate savings of ¾ percent of GDP.
  - The incremental adjustment recommended for 2017 is ½ percent of GDP; savings could be used to achieve the deficit target and address other needs such as health, education, or gradual implementation of a unified wage law.
  - Staff supported efforts to bolster efficiency and transparency in government spending and public administration:
    - Prioritize large public investment projects and extend prioritization to medium-sized and local government investments.
    - Enhance transparency of spending of public entities and widen use of centralized procurement.
    - Recommend early passage of the public procurement law to improve accountability and efficiency.
    - Start the government’s planned spending review with a few pilot sectors to identify efficiency gains.
    - Strengthen targeting of social protection schemes.
    - Approval of the draft law on natural resource taxation will give certainty on the tax framework.
- Fiscal targets and gaps (cash basis)
  - Budget deficit under current policies (IMF estimate): 2016 2.8; 2017 3.3; 2018 3.3 (percent of GDP)
  - Authorities' budget target: 2016 2.8; 2017 2.8; 2018 2.3 (percent of GDP)
  - Measures needed (cumulative) to reach authorities' target: 2016 0.0; 2017 0.5; 2018 1.0 (percent of GDP)
  - IMF-recommended budget: 2016 2.5; 2017 2.0; 2018 1.5 (percent of GDP)
  - Additional measures needed (cumulative) to reach IMF-recommended budget: 2016 0.3; 2017 0.8; 2018 0.8 (percent of GDP)
  - Note: The 2017 target of 2.8 percent of GDP in cash terms corresponds to around 3 percent in ESA terms.
- Visualized fiscal impacts (text table summary)
  - New tax code: 2016 -1.4; 2017 -0.8 (percent of GDP)
    - Value-added tax: 2016 -1.0; 2017 -0.4
    - Excises: 2016 0.0; 2017 -0.3
    - Personal Income Taxes: 2016 -0.3; 2017 0.0
    - Corporate Income Taxes: 2016 -0.1; 2017 0.0
    - Property taxation: 2016 0.0; 2017 -0.1
  - Public wage measures: 2016 1.0; 2017 0.0
    - Additional spending: 2016 1.5; 2017 0.0
    - Additional revenues (mainly social security contributions): 2016 0.5; 2017 0.0
  - Total effect on the budget: 2016 2.4; 2017 0.8 (percent of GDP)

### Fiscal rules, institutions, and enforcement
- The Fiscal Responsibility Law (FRL), fiscal council, and fiscal rule follow European standards (Annex V).
- The budget for 2016, approved outside the context of a program with international financial institutions, breaches the fiscal rule.
- The budget law waived the provisions of the FRL and of the fiscal rule to permit the 2016 budget.
- Scope for improvement:
  - Better integrate the Fiscal Council’s work into the decision making of parliament.
  - Increase public awareness of the rules.
  - Better track the risk of breaching the rules.
  - Strengthen the automatic sanctions envisaged by the FRL to incentivize responsible parties to apply the rules.
- Authorities’ views on fiscal targets
  - Authorities agreed with anchoring fiscal policy on a debt reduction path.
  - They believed next year’s deficit target was achievable without further measures and that there was little appetite in parliament to reduce the deficit further.
  - Authorities were confident that this year’s cash deficit target of 2.8 percent of GDP would be met.
  - For next year, authorities believed the deficit target of 2.8 percent was achievable without further measures, unlike staff projections.
  - Authorities viewed that reducing the 2017 deficit further would require legislative action, such as postponing the further tax reductions on VAT and excises scheduled to come into effect in 2017, for which they expected to find little support in parliament.

### Structural reforms, investment, and anticorruption
- Structural reforms — overview and need
  - A renewed push for structural reforms is needed to improve public and private investment and raise potential growth.
  - Structural reforms were a main focus of the most recent Fund-supported program; the program went off track partially because of insufficient progress on structural reforms.
  - Progress has been made to improve governance, but other structural reforms have stalled.
  - Private investment remains well below pre-crisis levels.
  - Key challenges: improve corporate governance of state-owned enterprises (SOEs); restructure SOEs with long-standing problems that pose a drain on the budget; raise EU-funds absorption; improve the investment climate.
- Corruption: findings and reform progress
  - Corruption has been one of the top three obstacles for doing business in Romania according to the World Bank’s and EBRD’s Business Environment and Enterprise Performance survey.
  - Corruption is associated with lower tax collections as evidenced by Romania’s large VAT gap in the EU (estimated at almost 6 percent of GDP).
  - In a recent EU survey over half of companies that participated in a public procurement procedure in the last three years believed there was collusive bidding, conflict of interests in the evaluation of bids, and bribes and kickbacks.
  - Romania is one of two countries in the EU subject to the “cooperation and verification mechanism” to help improve governance.
  - Authorities’ anti-corruption measures:
    - Passage of a new Criminal and Criminal Procedures Code in 2014.
    - Stepped up efforts to investigate and prosecute those suspected of corruption, including high profile figures.
    - Expedited judicial process to secure convictions.
    - Measures to enhance transparency and efficiency of government spending.
  - Outcome: Romania’s ranking in corruption indicators has improved; EC noted in January 2016 that the “track record of the key judicial and integrity institutions to address high-level corruption has remained impressive.”
  - Remaining reforms needed:
    - Public procurement and allocation of public funding.
    - Effectiveness of corruption investigations.
    - Establishment of conflict of interest rules.
    - Strengthening the National Integrity Agency’s capabilities to monitor asset declarations.
- Improving public investment and SOE reform
  - Reforms improving efficiency of public investment in critical infrastructure are essential for sustainable growth.
  - Staff recommended:
    - Early adoption and steadfast implementation of the draft legislation on improving corporate governance of SOEs.
    - Accelerate initial public offerings (IPOs) and the privatization program.
    - Put all SOEs on a firm financial footing (aggressive restructuring or liquidation where required).
  - Expected outcomes:
    - Improved professionalism of SOE management.
    - Better resource allocation and higher profitability.
    - Reduced subsidies and contained contingent liabilities for the state.
  - Energy sector: market deregulation for non-residential consumers largely successful; deregulation for residential consumers should continue.
- Improving absorption of EU funds
  - Actions to boost EU funds absorption:
    - Pass the draft procurement law currently in parliament transposing EU directives.
    - Prepare an action plan for the new programming period (2014–20).
    - Appropriately prepare documentation to be sent to the EC to avoid delays in processing.
    - Prioritize projects.
    - Shift ongoing projects under the 2007–13 programming period to the 2014–20 period where feasible.
    - Systematically limit domestic financing of projects that qualify for EU funds.
- Raising private investment and tax administration reforms
  - Making regulations and tax administration business friendly will support revenues and attract private investment, particularly FDI.
  - Romania ranks 37th out of 189 countries in the 2016 Doing Business rankings.
  - Areas for improvement: construction permits, property registration, protection of minority investors, tax administration.
  - Tax administration reform focus:
    - Taxpayers’ single window.
    - Electronic filing.
    - Consolidation of small taxes.
    - Online centralized taxpayer database.
    - Improving timeliness of VAT refunds.
    - Strengthen the risk-based audit system and large taxpayer unit.
  - Authorities have requested further Fund technical assistance in this area.

### Minimum wage policy
- Concern: Minimum wage rises well beyond productivity gains could do more harm than good (Annex VII and Selected Issues Paper).
- With the sharp hike planned for this year, the ratio of minimum-to-average wage in Romania will surpass the regional average.
- Risks: undermine external competitiveness and hamper job creation, particularly for low-skilled labor and in labor-intensive industries.
- Staff recommendation: the pace of future minimum wage increases should be moderate and balance social considerations with competitiveness, productivity growth, and employment prospects.
- Suggested institutional measure: establish labor market expert committee and periodically reassess impact of labor market policy including minimum wages.
- Authorities’ actions:
  - Established a working group comprising government officials and social partners to study and make clear guidelines for setting the minimum wage, following the EC’s recommendation.
  - The working group is expected to present the new proposal by May 2016.
- Annex VII highlights
  - Minimum wages will be raised in May 2016, resulting in about 78.6 percent increase compared to end-2012.
  - With the planned increase in 2016, the minimum wage in Romania would leap to approximately 45.3 percent of mean wage and 65.4 percent of median wage.
  - In 2013, approximately 430,000 workers had wages at or below the minimum wage, about 11.2 percent of total workers registered.
  - Minimum wage workers concentrated in construction, trade, manufacturing, hotels and restaurants.
  - The share of workers at or below the minimum wage rose to 11.3 percent after the first hike in 2013, from around 4 percent in 2012.

### Monetary policy: stance, transmission, and recommendations
- Policy rate trajectory: declined from 6 percent in 2011 to the current 1.75 percent.
- The NBR narrowed the interest rate corridor and reduced minimum reserve requirements (MRRs) on both leu- and FX-denominated liabilities.
- There has been a persistent gap between the interbank and the policy rates which could undermine effectiveness of the monetary policy framework.
- Easy monetary conditions and a sharp increase in government spending in late 2015 have contributed to a buildup of liquidity in the banking system.
- Real interest rates, adjusting for underlying inflation, have turned negative.
- Headline inflation is currently negative; underlying inflation adjusted for recent tax changes has been rising.
- Staff and NBR projections: headline inflation (without policy action) is expected to rise to close to 3½ percent, the upper bound of the variation band of the inflation target, by end-2017.
- Staff recommendations:
  - Leave the policy rate unchanged for now but begin to reduce the gap between the policy and interbank rates.
  - Consider signaling a tightening bias and begin to reduce the gap between market and policy rates by absorbing liquidity and narrowing the interest rate corridor.
  - Monetary policy may need to shoulder some of the burden for managing domestic demand given the large pro-cyclical fiscal impulse.
- Staff assessment: the Romanian leu is broadly in line with medium-term fundamentals (Annex IV); Romania’s external position in 2015 was broadly in line with fundamentals; reserve coverage is broadly adequate according to most reserve adequacy metrics.
- NBR actions: limited interventions in 2015 compared to previous year; increased FX sales in late 2015 and early 2016 due to excess liquidity and worsening global sentiment.

### Financial sector: stability, legal risks, and intermediation
- Authorities need to sustain efforts to improve bank balance sheets and resist measures that could undermine banking system stability and legal predictability.
- Recent reduction in NPLs is welcome; encourage continued write-offs and sales of distressed assets.
- Key near-term risk: legislative initiatives allowing unilateral and retroactive changes to contracts.
  - In April 2016, parliament adopted a law allowing consumers to unilaterally discharge any debt owed to banks that is collateralized by residential real property through transfer of the collateral to the creditor (“Giving in Payment” law).
  - Concerns: the law is not well targeted; retroactive application could negatively affect bank balance sheets, undermine private property rights, legal predictability, investor sentiment, and curtail credit provision.
- Staff advice:
  - Debt relief to distressed borrowers should be targeted with stringent eligibility requirements while respecting sanctity of contracts and adequate safeguards.
  - Revisit elements of existing legislation on abusive clauses to reduce uncertainty while securing fairness.
  - Put in place prerequisites (institutional infrastructure, implementing regulations, operational systems, templates) for implementing the recently adopted personal insolvency law.
- Medium-term challenge: raise financial intermediation to better serve growth needs.
  - Romania has one of the lowest ratios of private credit to GDP in the region and relatively moderate levels of corporate and household debt.
  - Raising intermediation requires boosting domestic deposits and developing alternative sources of funding for the banking sector absent renewed flows from parent banks.
  - The new covered bond law should contribute to development of long-term bank funding and intermediation, although enforcement of the “Giving in Payment” law may jeopardize covered bond issuance.
  - Sustaining NPL reduction progress and results of the ongoing asset quality review will help identify further efforts needed.
- Insurance sector and supervision:
  - Significant progress made on restructuring the Financial Supervisory Authority (FSA) and strengthening its intervention and resolution tools.
  - FSA implemented comprehensive balance sheet reviews and stress testing covering virtually the whole insurance sector; reviews revealed deficiencies including capital shortfalls in several insurance companies.
  - The largest insurance company entered bankruptcy in late 2015; another major insurance company is currently under resolution.
  - Staff welcomed progress to strengthen the FSA and encouraged it to address revealed shortfalls to ensure adequate capitalization in the insurance sector.

### Authorities’ stance and staff appraisal
- Authorities broadly agreed with staff’s views and shared concerns regarding potentially harmful legislative initiatives; they mentioned additional capital buffers as a possible contingency measure.
- Authorities expressed commitment to improve financial intermediaries’ portfolios and ensure adequate capital in bank and non-bank institutions.
- Staff appraisal overview:
  - Romania made important progress in reducing vulnerabilities after the global financial crisis but the recent weakening of policies puts the gains at risk.
  - Fiscal and current account deficits have improved markedly since the crisis and banks’ loan portfolio quality has strengthened.
  - Stronger policies and fundamentals have helped Romania achieve robust growth and avoid pressures from elevated market volatility.
  - It is important that sound policies and reforms continue to sustain strong and inclusive growth, at a time that downside risks have increased.

### Recommendation on IMF consultation cycle
- It is recommended to hold the next Article IV consultation on the standard 12-month cycle.

### Mortgage-backed loans (end-February 2016) — key figures (source table)
- Loan agreements (thous.): Residential mortgages 99.0; Housing development 75.8; Consumer loans 168.3; Total 343.2
- Number of loans overdue 30+ days (thous.): Residential mortgages 4.7; Housing development 4.8; Consumer loans 17.6; Total 27.1
- Outstanding loans (billion lei): Residential mortgages 15.7; Housing development 10.2; Consumer loans 20.9; Total 46.8
- Loans overdue 30+ days (billion lei): Residential mortgages 0.90; Housing development 0.93; Consumer loans 3.0; Total 4.7
- Share of overdue loans (percent): Residential mortgages 5.9; Housing development 8.5; Consumer loans 14.1; Total 10.1

### Box 2 — Debt Discharge (Giving in Payment) Law (summary)
- Description
  - Law permitting discharge of debt obligations assumed through credit agreements through transfer of mortgaged property.
  - First approved by the parliament in November 2015; President Iohannis sent the bill back to the parliament for reconsideration; parliament approved the law in a final vote in April 2016.
- Eligibility and scope
  - Permits consumers, co-debtors and pledgors meeting criteria to discharge loans in entirety via transfer of collateral:
    - (i) the loan is less than 250,000 euros at origination;
    - (ii) the loan is collateralized by residential real property; and
    - (iii) the creditors are credit institutions, non-bank financial institutions or their assignees.
  - If exercised by the debtor, the creditor would no longer have recourse to any other assets or income of the debtor beyond the pledged collateral in case of any deficiency claim.
  - Retroactive application to existing loans, including foreclosed or ongoing foreclosure cases.
- Legal and institutional concerns
  - Romanian banks and NBR argue some provisions create legal uncertainties, moral hazard, and may pose systemic risk to banks.
  - ECB opinion (December 18, 2015): draft law introduces unprecedented changes and will significantly undermine legal certainty and the adequate management of credit risk.
  - EC has also expressed major concerns including regarding retroactive applicability.
- Quantitative estimates of potential impact
  - Amount of overdue loans eligible: around RON 5 billion — potential lower limit of write-offs (net of provisions).
  - “Underwater mortgage” scenario: assumption of 20 percent of total loans being taken advantage of adds RON 8 billion to possible write-offs.
  - Combined range for potential write-offs: RON 5–13 billion.
  - Asset-sale loss assumption (25 percent loss on sale of immovable property): overall loss to banks in range RON 1.3–3.3 billion.
  - Estimated overall loss could be up to 4 percent of commercial banks total capital.
- Additional operational and systemic risks
  - Banks will incur additional operational expenses to manage and sell portfolios of immovable property.
  - Negative spillovers: undermining future credit expansion and investor confidence; risks of contingent liabilities for the state if banks pursue compensation claims.
- Policy implications
  - Retroactive and unilateral contract changes create legal uncertainty and impair adequate management of credit risk.
  - Potential fiscal and financial stability implications warrant careful consideration of legal design, scope, and safeguards.

### Debt Sustainability Analysis — public debt: baseline and risks (selected)
- Baseline macro-fiscal assumptions
  - Output gap: expected to be slightly positive in 2016–18 and to be closed by 2021.
  - Real growth: close to 4 percent in 2016 and stabilize at slightly above 3 percent afterwards.
  - Fiscal balance: projected to deteriorate from 1.5 percent in 2015 to 2.8 percent (in cash terms; close to 3 percent in ESA terms) in 2016 and to remain close to 3 percent afterwards up until 2021.
- Public debt levels and composition
  - Public debt, including guarantees, is estimated at 39.3 percent of GDP in 2015.
  - Projected to increase to about 42 percent by 2021.
  - Gross financing needs: projected to remain rather stable at about 8 percent of GDP over the projection horizon.
  - Foreign currency financing buffer (excluding privatization proceeds): about 3.3 percent of GDP or almost five months of gross financing needs.
  - SOE debt (including SOEs under insolvency procedures): around 7.5 percent of GDP.
- Stress tests and risks
  - Weaker GDP growth could push the debt ratio to 55 percent of GDP by 2021.
  - A combination of adverse macro shocks could push the debt above 60 percent threshold of the Stability and Growth Pact by 2020 (though below the 70 percent DSA benchmark).

### External sector and reserve assessment (selected)
- Staff’s overall assessment: Romania’s external position in 2015 was broadly in line with fundamentals.
- Net international investment position (IIP) in 2015: -50.2 percent of GDP (improvement since 2014: 6.7 percentage points).
- Current account deficit narrowed from 11.8 percent of GDP in 2008 to 1.1 percent of GDP in 2015; staff expects it to gradually widen to 3.5 percent of GDP in the medium term.
- Real exchange rate: depreciated by around 4 percent in 2015; staff assesses REER broadly in line with equilibrium with modest undervaluation indicated by EBA-lite indices.
- Reserve adequacy
  - Reserve level at end-December 2015: €35.5 billion.
  - Reserves above standard rules of thumb: three months coverage of prospective imports and 20 percent of broad money.
  - Reserves in line with new reserve adequacy metric for emerging markets developed by Fund staff.
  - Reserves slightly short of 100 percent short-term debt benchmark (at remaining maturity), but metric improved due to reduction in short-term external liabilities.
  - Policy implication: prudent stance with moderate reserve accumulation remains appropriate.

### Annex I — Implementation of 2015 Article IV Key Recommendations (selected)
- Maintain fiscal adjustment achievements and put public debt as a share of GDP on a downward path: 2015 fiscal deficit lower than targeted and public debt as a share of GDP declined, but 2016 budget envisages a substantially higher deficit raising the public debt ratio.
- Improve revenue administration: several administrative measures implemented; tax collection gap remains substantial.
- Improve public expenditure management including through higher EU funds absorption: limited progress toward better investment planning and execution.
- Continue intense watch on banking and insurance sectors with focus on asset quality: balance sheet review of major insurance companies; asset quality review for major banks initiated.
- Create effective insolvency frameworks: personal insolvency law adopted but enforcement delayed by one year amid lack of secondary legislation and institutions.
- Reduce non-performing loans (NPL): continued efforts and sharp recent reduction in the NPL ratio.
- Further deregulate energy markets: implemented gas price deregulation for non-residential consumers; continued electricity market deregulation.
- Improve financial performance of SOEs through better governance and restructuring: weak implementation of SOE corporate governance law; strengthened legislation prepared but still to be adopted.

### Risk Assessment Matrix — selected risks and policy responses
- Tighter or more volatile global financial conditions (Relative Likelihood: Medium). Policy response: utilize some fiscal financing buffer; allow exchange rate flexibility; offset excessive volatility.
- A further deterioration in the fiscal balance above the targeted budget (Relative Likelihood: Medium). Policy response: reverse tax cuts, restrain wage increases, cut lower priority expenditure; improve tax administration.
- Persistent shortfall in public investment including weak EU funds absorption (Relative Likelihood: High). Policy response: improve EU projects implementation capacity; strengthen procurement framework.
- Adoption of potentially harmful legislation for financial sector (Relative Likelihood: Medium). Policy response: provide liquidity to solvent banks that come under stress.
- Sharper-than-expected global growth slowdown (Relative Likelihood: Medium). Policy response: allow limited use of automatic stabilizers; accelerate EU funds absorption; allow exchange rate flexibility.
- Persistently lower energy prices and low inflation in euro area (Relative Likelihood: High). Policy response: ease monetary policy if deflationary pressures materialize; strengthen policy communication.

*Source: IMF staff report (Romania Article IV consultation chapter).*

### 1. Romania’s Recent Anticorruption Campaign __________________________________________________ 19

### 1. Romania’s Recent Anticorruption Campaign

### Background and governance
- Romania made important progress in addressing economic imbalances and restoring growth after the global financial crisis through prudent policies and Fund-supported programs.
- Per capita income has surpassed pre-crisis levels and growth is projected to be amongst the highest in the region in the near term.
- Governance problems received more attention recently; Romania has been recognized for progress in the fight against corruption and the anticorruption agency has high public opinion ratings.
- Romania’s position in perception of corruption indicators produced by Transparency International and the World Bank has improved in recent years.

### Recent economic developments
- Growth dynamics
  - The economy is on a cyclical upswing supported by strong domestic demand driven mainly by private consumption and recent hikes in minimum and public wages.
  - Investment showed signs of pickup partly related to catch-up in EU funds absorption and helped offset a weakening of exports in the second half of the year.
- Inflation and wages
  - Annual headline inflation turned negative in June 2015 following a reduction in VAT on food items from 24 to 9 percent.
  - Adjusting for VAT changes, underlying inflation has remained positive and been rising.
  - Overall wages grew by 11.6 percent (y/y) in January 2016, reflecting public wage and minimum wage hikes.
  - Minimum wage expected to be raised to 1,250 lei in May 2016 from 1,050 lei (about €265).
  - Unit labor costs increased by 2.2 percent in 2015 and by 7.6 percent since 2010.
- Fiscal outcomes and public debt
  - General government deficit (cash basis) was 1.5 percent of GDP in 2015, compared to 1.8 percent in the original budget.
  - Revenues were 1.3 percent of GDP higher than budgeted in 2015.
  - Total expenditure was 0.9 percent of GDP higher mainly due to personnel spending.
  - Public debt stood at around 40 percent at end-2015.
  - Preliminary data: the budget recorded a surplus of 0.4 percent of GDP in the first quarter compared to 0.7 percent in the same period of 2015; the difference reflects mainly lower VAT revenues.
- External sector and reserves
  - Current account deficit is small and widened modestly in 2015, driven by an increase in the goods trade deficit and an almost doubling of the primary income deficit.
  - Gross reserves of €35.5 billion at end-2015 were broadly adequate by most reserve adequacy metrics.
  - The current account deficit is projected to gradually widen in 2016–17 and reach around 3.5 percent of GDP over the medium term.
- Banking sector and financial stability
  - NPL ratio fell to 14 percent at end-2015 compared to a peak of 22 percent in 2014Q1 (reflecting write-offs and sales).
  - Credit growth: local currency lending growth more than offset continued decline in foreign currency lending.
  - Banking system enjoys comfortable levels of capital adequacy and liquidity; profitability is improving.
  - Exposures and risks: FX mismatches in borrowers’ balance sheets and market risk related to large bond holdings.
  - Stress episode: four Greek-owned Romanian banks experienced substantial deposit withdrawals last summer; withdrawals have largely been reversed.
  - NBR introduced additional capital buffer requirements: capital conservation buffer, countercyclical capital buffer (currently set at zero), buffer for systemically important institutions, and a systemic risk buffer.

### Outlook and risks
- Staff baseline projections and assumptions
  - Growth expected to remain above potential in 2016–17, with a near-term cyclical acceleration driven mostly by domestic consumption and a strong fiscal impulse, then returning gradually to potential.
  - Underlying inflation expected to gradually pick up.
  - Current account deficit expected to widen on import growth.
  - Baseline assumes authorities will not exceed 3 percent of GDP deficit in ESA terms (2.8 percent of GDP on a cash basis); achieving this would require additional measures.
- Key projections (selected macroeconomic outlook table)
  - Real GDP (yoy): 2014 3.0; 2015 3.8; 2016 4.2; 2017 3.6; 2018 3.3
  - CPI inflation (yoy, eop): 2014 0.8; 2015 -0.9; 2016 1.5; 2017 3.4; 2018 2.7
  - Unemployment rate (average): 2014 6.8; 2015 6.8; 2016 6.4; 2017 6.2; 2018 6.3
  - Current account balance: 2014 -0.5; 2015 -1.1; 2016 -1.7; 2017 -2.5; 2018 -2.7
  - Fiscal balance (cash): 2014 -1.9; 2015 -1.5; 2016 -2.8; 2017 -2.8; 2018 -2.8
  - Gross external debt (percent of GDP): 2014 63.1; 2015 56.7; 2016 58.7; 2017 56.6; 2018 52.7
  - Gross general government debt (percent of GDP): 2014 38.7; 2015 38.1; 2016 37.4; 2017 37.0; 2018 38.1
- Risks
  - Downside risks tilted to the downside, mainly related to the pre-electoral environment and external uncertainties.
  - Further fiscal stimulus in an election year may boost consumption short term but undermine sustainability of public finances and market sentiment.
  - Inappropriate measures targeting the financial sector without proper impact analysis and consultation could harm credit intermediation, investment, and financial stability.
  - External risk: abrupt deterioration in emerging market risk perception could trigger currency depreciation and raise the external debt-to-GDP ratio.
  - Mitigation: maintaining adequate reserve levels, exchange rate flexibility, and fiscal buffers will be key.

### Fiscal policy assessment and recommendations
- Recent policy changes and fiscal stance
  - Authorities adopted in late 2015 a package of large tax cuts costing 1.4 percent of GDP in 2016 and a further 0.8 percent of GDP in 2017.
  - Measures include reduction of the standard VAT rate from 24 to 20 percent in 2016 and to 19 percent in 2017, reduction of fuel excises, dividend tax, health contributions and the elimination of the special construction tax.
  - Several expenditure-expanding measures introduced, notably ad-hoc salary increases costing 1½ percent of GDP in gross terms.
  - Staff projects the cash deficit to escalate to 3¼ percent in 2017 under current policies, well above the authorities’ cash deficit target of 2.8 percent of GDP for 2016 and 2017.
  - Even if the authorities’ deficit path is achieved, public debt will exceed 40 percent of GDP and continue to gradually rise over the medium term.
- Staff diagnosis
  - Fiscal policy is pro-cyclical and implies a structural relaxation of 2¼ percent in 2016.
  - The stance is inappropriate from demand management perspective and risks returning Romania to pre-crisis patterns.
  - Public debt tripled between 2008 and 2015, indicating vulnerability and the need for fiscal buffers.
  - Importance of keeping debt on a downward path emphasized in previous Article IV consultations.
- Staff recommendations and targets
  - Anchor fiscal policy on a well-defined debt-reduction path.
  - Staff recommended gradual adjustment to lower the cash deficit to 1.5 percent of GDP by 2018.
  - Immediate effort: find and preserve savings to keep the deficit below 2.5 percent of GDP in 2016.
  - For 2017, staff recommended a deficit of 2 percent of GDP.
  - Suggested measure: postpone further tax reductions on VAT and excises scheduled for next year until offsetting measures are identified—this would generate savings of ¾ percent of GDP.
  - The incremental adjustment recommended for 2017 is ½ percent of GDP; savings could be used to achieve the deficit target and address other needs such as health, education, or gradual implementation of a unified wage law.
  - Staff supported efforts to bolster efficiency and transparency in government spending and public administration:
    - Prioritization of large public investment projects and recommendation to extend prioritization to medium-sized and local government investments.
    - Enhance transparency of spending of public entities and widen use of centralized procurement.
    - Recommend early passage of the public procurement law to improve accountability and efficiency.
    - Government plans to carry out a spending review; staff recommended starting with a few pilot sectors to identify efficiency gains.
    - Strengthen targeting of social protection schemes.
    - Approval of the draft law on natural resource taxation will give certainty on the tax framework.
- Fiscal targets and gaps (cash basis)
  - Budget deficit under current policies (IMF estimate): 2016 2.8; 2017 3.3; 2018 3.3 (percent of GDP)
  - Authorities' budget target: 2016 2.8; 2017 2.8; 2018 2.3 (percent of GDP)
  - Measures needed (cumulative) to reach authorities' target: 2016 0.0; 2017 0.5; 2018 1.0 (percent of GDP)
  - IMF-recommended budget: 2016 2.5; 2017 2.0; 2018 1.5 (percent of GDP)
  - Additional measures needed (cumulative) to reach IMF-recommended budget: 2016 0.3; 2017 0.8; 2018 0.8 (percent of GDP)
  - Note: The 2017 target of 2.8 percent of GDP in cash terms corresponds to around 3 percent in ESA terms.
- Visualized fiscal impacts (text table summary)
  - New tax code: 2016 -1.4; 2017 -0.8 (percent of GDP)
    - Value-added tax: 2016 -1.0; 2017 -0.4
    - Excises: 2016 0.0; 2017 -0.3
    - Personal Income Taxes: 2016 -0.3; 2017 0.0
    - Corporate Income Taxes: 2016 -0.1; 2017 0.0
    - Property taxation: 2016 0.0; 2017 -0.1
  - Public wage measures: 2016 1.0; 2017 0.0
    - Additional spending: 2016 1.5; 2017 0.0
    - Additional revenues (mainly social security contributions): 2016 0.5; 2017 0.0
  - Total effect on the budget: 2016 2.4; 2017 0.8 (percent of GDP)

*Source: IMF staff report (Romania Article IV consultation chapter).*

### 17.      The national and sub-national fiscal rules are sound but their enforcement has been

### 17.      The national and sub-national fiscal rules are sound but their enforcement has been weak, undermining the credibility of the fiscal institutions.

### Fiscal rules, institutions, and enforcement
- The Fiscal Responsibility Law (FRL), fiscal council, and fiscal rule follow European standards (Annex V).
- The budget for 2016, approved outside the context of a program with international financial institutions, breaches the fiscal rule.
- The budget law waived the provisions of the FRL and of the fiscal rule to permit the 2016 budget.
- Scope for improvement:
  - Better integrate the Fiscal Council’s work into the decision making of parliament.
  - Increase public awareness of the rules.
  - Better track the risk of breaching the rules.
  - Strengthen the automatic sanctions envisaged by the FRL to incentivize responsible parties to apply the rules.

### Authorities’ views on fiscal targets
- Authorities agreed with anchoring fiscal policy on a debt reduction path.
- They believed next year’s deficit target was achievable without further measures and that there was little appetite in parliament to reduce the deficit further.
- Authorities were confident that this year’s cash deficit target of 2.8 percent of GDP would be met.
- For next year, authorities believed the deficit target of 2.8 percent was achievable without further measures, unlike staff projections.
- Authorities viewed that reducing the 2017 deficit further would require legislative action, such as postponing the further tax reductions on VAT and excises scheduled to come into effect in 2017, for which they expected to find little support in parliament.

### Structural reforms — overview and need
- A renewed push for structural reforms is needed to improve public and private investment and raise potential growth.
- Structural reforms were a main focus of the most recent Fund-supported program; the program went off track partially because of insufficient progress on structural reforms.
- Progress has been made to improve governance, but other structural reforms have stalled.
- Private investment remains well below pre-crisis levels.
- Key challenges:
  - Improve corporate governance of state-owned enterprises (SOEs).
  - Restructure SOEs with long-standing problems that pose a drain on the budget.
  - Raise EU-funds absorption.
  - Improve the investment climate.

### Corruption: findings and reform progress
- Corruption has been one of the top three obstacles for doing business in Romania according to the World Bank’s and EBRD’s Business Environment and Enterprise Performance survey.
- Corruption is associated with lower tax collections as evidenced by Romania’s large VAT gap in the EU (estimated at almost 6 percent of GDP).
- In a recent EU survey over half of companies that participated in a public procurement procedure in the last three years believed there was collusive bidding, conflict of interests in the evaluation of bids, and bribes and kickbacks.
- Romania is one of two countries in the EU subject to the “cooperation and verification mechanism” to help improve governance.
- Authorities’ anti-corruption measures:
  - Passage of a new Criminal and Criminal Procedures Code in 2014.
  - Stepped up efforts to investigate and prosecute those suspected of corruption, including high profile figures.
  - Expedited judicial process to secure convictions.
  - Measures to enhance transparency and efficiency of government spending (discussed in ¶16).
- Outcome: Romania’s ranking in corruption indicators has improved; EC noted in January 2016 that the “track record of the key judicial and integrity institutions to address high-level corruption has remained impressive.”
- Remaining reforms needed:
  - Public procurement and allocation of public funding.
  - Effectiveness of corruption investigations.
  - Establishment of conflict of interest rules.
  - Strengthening the National Integrity Agency’s capabilities to monitor asset declarations.

### Improving public investment and SOE reform
- Reforms improving efficiency of public investment in critical infrastructure are essential for sustainable growth.
- SOEs play an important role in major infrastructure sectors.
- Staff recommended:
  - Early adoption and steadfast implementation of the draft legislation on improving corporate governance of SOEs.
  - Accelerate initial public offerings (IPOs) and the privatization program.
  - Put all SOEs on a firm financial footing (aggressive restructuring or liquidation where required).
- Expected outcomes:
  - Improved professionalism of SOE management.
  - Better resource allocation and higher profitability.
  - Reduced subsidies and contained contingent liabilities for the state.
- Energy sector: market deregulation for non-residential consumers largely successful; deregulation for residential consumers should continue.

### Improving absorption of EU funds
- Actions to boost EU funds absorption:
  - Pass the draft procurement law currently in parliament transposing EU directives.
  - Prepare an action plan for the new programming period (2014–20).
  - Appropriately prepare documentation to be sent to the EC to avoid delays in processing.
  - Prioritize projects.
  - Shift ongoing projects under the 2007–13 programming period to the 2014–20 period where feasible.
  - Systematically limit domestic financing of projects that qualify for EU funds.

### Raising private investment and tax administration reforms
- Making regulations and tax administration business friendly will support revenues and attract private investment, particularly FDI.
- Romania ranks 37th out of 189 countries in the 2016 Doing Business rankings.
- Areas for improvement: construction permits, property registration, protection of minority investors, tax administration.
- Tax administration reform focus:
  - Taxpayers’ single window.
  - Electronic filing.
  - Consolidation of small taxes.
  - Online centralized taxpayer database.
  - Improving timeliness of VAT refunds.
  - Strengthen the risk-based audit system and large taxpayer unit.
- Authorities have requested further Fund technical assistance in this area.

### Minimum wage policy
- Concern: Minimum wage rises well beyond productivity gains could do more harm than good (Annex VII and Selected Issues Paper).
- With the sharp hike planned for this year, the ratio of minimum-to-average wage in Romania will surpass the regional average.
- Risks: undermine external competitiveness and hamper job creation, particularly for low-skilled labor and in labor-intensive industries.
- Staff recommendation: the pace of future minimum wage increases should be moderate and balance social considerations with competitiveness, productivity growth, and employment prospects.
- Suggested institutional measure: establish labor market expert committee and periodically reassess impact of labor market policy including minimum wages.
- Authorities’ actions:
  - Established a working group comprising government officials and social partners to study and make clear guidelines for setting the minimum wage, following the EC’s recommendation.
  - The working group is expected to present the new proposal by May 2016.

### Monetary policy: stance, transmission, and recommendations
- Policy rate trajectory: declined from 6 percent in 2011 to the current 1.75 percent.
- The NBR narrowed the interest rate corridor and reduced minimum reserve requirements (MRRs) on both leu- and FX-denominated liabilities.
- There has been a persistent gap between the interbank and the policy rates which could undermine effectiveness of the monetary policy framework.
- Easy monetary conditions and a sharp increase in government spending in late 2015 have contributed to a buildup of liquidity in the banking system.
- Real interest rates, adjusting for underlying inflation, have turned negative.
- Headline inflation is currently negative; underlying inflation adjusted for recent tax changes has been rising.
- Staff and NBR projections: headline inflation (without policy action) is expected to rise to close to 3½ percent, the upper bound of the variation band of the inflation target, by end-2017.
- Staff recommendations:
  - Leave the policy rate unchanged for now but begin to reduce the gap between the policy and interbank rates.
  - Consider signaling a tightening bias and begin to reduce the gap between market and policy rates by absorbing liquidity and narrowing the interest rate corridor.
  - Monetary policy may need to shoulder some of the burden for managing domestic demand given the large pro-cyclical fiscal impulse.
- Staff assessment: the Romanian leu is broadly in line with medium-term fundamentals (Annex IV); Romania’s external position in 2015 was broadly in line with fundamentals; reserve coverage is broadly adequate according to most reserve adequacy metrics.
- NBR actions: limited interventions in 2015 compared to previous year; increased FX sales in late 2015 and early 2016 due to excess liquidity and worsening global sentiment.

### Financial sector: stability, legal risks, and intermediation
- Authorities need to sustain efforts to improve bank balance sheets and resist measures that could undermine banking system stability and legal predictability.
- Recent reduction in NPLs is welcome; encourage continued write-offs and sales of distressed assets.
- Key near-term risk: legislative initiatives allowing unilateral and retroactive changes to contracts.
  - In April 2016, parliament adopted a law allowing consumers to unilaterally discharge any debt owed to banks that is collateralized by residential real property through transfer of the collateral to the creditor (“Giving in Payment” law).
  - Concerns: the law is not well targeted; retroactive application could negatively affect bank balance sheets, undermine private property rights, legal predictability, investor sentiment, and curtail credit provision.
- Staff advice:
  - Debt relief to distressed borrowers should be targeted with stringent eligibility requirements while respecting sanctity of contracts and adequate safeguards.
  - Revisit elements of existing legislation on abusive clauses to reduce uncertainty while securing fairness.
  - Put in place prerequisites (institutional infrastructure, implementing regulations, operational systems, templates) for implementing the recently adopted personal insolvency law.
- Medium-term challenge: raise financial intermediation to better serve growth needs.
  - Romania has one of the lowest ratios of private credit to GDP in the region and relatively moderate levels of corporate and household debt.
  - Supply and demand factors have affected credit since the 2008 global financial crisis.
  - Recent indicators show some improvement in non-financial corporations’ liquidity and profitability; household incomes have been rising.
  - Raising intermediation requires boosting domestic deposits and developing alternative sources of funding for the banking sector absent renewed flows from parent banks.
  - The new covered bond law should contribute to development of long-term bank funding and intermediation, although enforcement of the “Giving in Payment” law may jeopardize covered bond issuance.
  - Sustaining NPL reduction progress and results of the ongoing asset quality review will help identify further efforts needed.
- Insurance sector and supervision:
  - Significant progress made on restructuring the Financial Supervisory Authority (FSA) and strengthening its intervention and resolution tools.
  - FSA implemented comprehensive balance sheet reviews and stress testing covering virtually the whole insurance sector; reviews revealed deficiencies including capital shortfalls in several insurance companies.
  - The largest insurance company entered bankruptcy in late 2015; another major insurance company is currently under resolution.
  - Staff welcomed progress to strengthen the FSA and encouraged it to address revealed shortfalls to ensure adequate capitalization in the insurance sector.

*Source: IMF country report text provided.*

### 34.      The authorities broadly agreed with staff’s views. They shared staff’s concerns regarding

### _cr16113 - 34.      The authorities broadly agreed with staff’s views. They shared staff’s concerns regarding

### Authorities’ stance
- The authorities broadly agreed with staff’s views.
- They shared staff’s concerns regarding the potential impact of harmful legislative initiatives and mentioned additional capital buffers as a possible contingency measure.
- They expressed commitment to further improve the quality of financial intermediaries’ portfolios and ensure that both bank and non-bank financial institutions hold adequate capital.
- They agreed that increasing financial intermediation is an important objective for the medium term including through promoting capital market development.

### Staff appraisal — overview
- Romania made important progress in reducing vulnerabilities after the global financial crisis but the recent weakening of policies puts the gains at risk.
- The fiscal and current account deficits have improved markedly since the global financial crisis and banks’ loan portfolio quality has strengthened.
- Stronger policies and fundamentals have helped Romania achieve robust growth and avoid pressures from elevated market volatility.
- It is important that sound policies and reforms continue to sustain strong and inclusive growth, at a time that downside risks have increased.

### Fiscal policy and public debt
- Romania achieved impressive fiscal consolidation since 2009—one of the largest amongst peers.
- The large fiscal relaxation approved last year provides stimulus when consumption growth is already strong.
- If no further measures are taken, next year’s fiscal deficit will likely breach the EU’s excessive deficit procedure (EDP) threshold.
- Even if the deficit is kept at the authorities’ cash budget target of 2.8 percent of GDP (3 percent in ESA terms), public debt will exceed 40 percent of GDP and continue to gradually rise.
- Gradual adjustment to reduce the cash deficit to 1½ percent of GDP by 2018 will help keep debt on a downward path.
- Postponing the tax reductions scheduled to come into effect in 2017 will help achieve this goal.

### Fiscal institutions and public administration
- The waiving of the provisions of the FRL and the fiscal rule undermines the credibility of the policy framework and the budget process.
- It is important that the work of the Fiscal Council is integrated better into decision making.
- Reforms to make public administration more efficient and transparent should be accelerated, including:
  - further progress in prioritization of public investment projects,
  - fully operationalizing the recently created spending review unit,
  - strengthening targeting of social protection schemes,
  - extending centralized procurement to generate savings,
  - passage of the public procurement law.
- Early passage of legislation on natural resource taxation will help to give certainty on the tax framework.

### Structural reforms, investment, and tax administration
- Continued structural reform efforts are needed to improve public and private investment and raise potential growth.
- Efficiency of public investment in critical infrastructure sectors can be enhanced by strengthening the corporate governance of SOEs—including through the passage of draft legislation in parliament—and better planning and utilization of EU funds.
- The tax administration agency should focus more on high revenue potential taxpayers while becoming more business friendly.
- Recommended tax administration reforms include: taxpayers’ single window, electronic filing, consolidation of small taxes, online centralized taxpayers’ database, and improving promptness of VAT refunds.

### Governance and anticorruption
- There has been welcome progress in the fight against corruption and more needs to be done; improving governance and the fight against corruption are macro-relevant in Romania.
- The anticorruption agency enjoys growing public confidence and efforts in this direction should be sustained.
- Corruption effects highlighted:
  - Romania’s VAT gap is the largest in the EU (text statement).
  - The size of the shadow economy in Romania was estimated to be 28 percent of GDP in 2014, which is the second highest percentage in the EU.
- DNA activity and outcomes:
  - In the course of 2015 alone, DNA indicted over 1,250 defendants, and this included the prime minister, former ministers, members of parliament, mayors, presidents of county councils, judges, prosecutors and a wide variety of senior officials.
  - DNA increased its interim asset freezing measures relating to these cases, to reach a figure of €452 million.
- External assessments and recommendations:
  - The EC in its most recent assessment (released in January 2016) described the “track record of the key judicial and integrity institutions to address high-level corruption has remained impressive.”
  - The CVM report stressed further consolidation of reform is needed and suggested strengthening prevention and control mechanisms with regard to public procurement and public contracts, including in state-owned companies, and strengthening safeguards for allocation of public funding.
  - GRECO recommended measures including provision of a transparent system for lifting parliamentary immunity for corruption investigations, establishment of conflicts of interest rules for parliamentarians, and strengthening the National Integrity Agency’s capabilities to monitor asset declarations.
  - Ensuring that the AML/CFT regime with respect to domestic politically exposed persons is in line with the international standard and effectively implementing AML/CFT tools could support efforts to prevent, deter and detect laundering of corruption proceeds.
- Anticorruption progress will support many Fund policy recommendations (e.g., spending efficiency, procurement reform, unified wage law, SOE corporate governance, tax compliance).

### Public and minimum wages
- Policies for public and minimum wages should take into account fiscal space and competitiveness considerations.
- On public sector wages, there is a need to eliminate the distortions in the remuneration system.
- Current budget plans do not provide fiscal space for the unified wage law that would help address these distortions.
- Postponement of the 2017 tax reductions would provide space for the phased implementation of this law.
- On minimum wage, moderating the pace of future increases will help balance social considerations with competitiveness, productivity growth, and employment prospects.

### Monetary policy
- A tightening bias in monetary policy is warranted on current inflation projections.
- Inflation projections have risen to the upper bound of the variation band of the central bank’s inflation target on account of a closing output gap, sharp wage increases, and the fiscal stimulus.
- While the policy rate can be left unchanged until projected inflation moves more clearly above target, the NBR should begin to reduce the gap between the market and policy rates by absorbing liquidity from the market and narrowing the interest rate corridor.
- Interventions in the foreign exchange market should be limited to smoothing excessive volatility.

### Financial stability and NPLs
- There has been important progress in reducing NPLs and threats to financial stability need to be guarded against.
- Sustained efforts towards reducing NPLs are welcome.
- Removing provisions in legislative initiatives that could undermine financial stability and legal predictability, and finding better ways to target relief to distressed borrowers, will mitigate risks.
- Increasing financial intermediation while maintaining financial sector stability will support growth needs.

### Recommendation on IMF consultation cycle
- It is recommended to hold the next Article IV consultation on the standard 12-month cycle.

### Mortgage-backed loans (end-February 2016) — key figures from source table
- Residential mortgages / Housing development / Consumer loans / Total
- Loan agreements (thous.)99.075.8168.3343.2
- Number of loans overdue 30+ days (thous.)4.74.817.627.1
- Outstanding loans (billion lei)15.710.220.946.8
- Loans overdue 30+ days (billion lei)0.90.93.04.7
- Share of overdue loans (percent)5.98.514.110.1

*Source: _cr16113 (Romania), IMF staff appraisal and boxes as provided in source content.*

### Box 2. Debt Discharge (Giving in Payment) Law

### Box 2. Debt Discharge (Giving in Payment) Law

### Description of the legislative initiative
- Law permitting discharge of debt obligations assumed through credit agreements through the transfer of mortgaged property (“Giving in Payment” law).
- Parliamentary approval timeline:
  - First approved by the parliament in November 2015.
  - President Iohannis sent the bill back to the parliament for reconsideration.
  - Parliament approved the law in a final vote in April 2016.
- Presented as a measure to help distressed households with mortgages.

### Eligibility and scope of the law
- The law permits consumers as well as their co-debtors and pledgors meeting the following criteria to discharge their loans in entirety through transfer of the collateral to creditors:
  - (i) the loan is less than 250,000 euros at origination;
  - (ii) the loan is collateralized by residential real property; and
  - (iii) the creditors are credit institutions, non-bank financial institutions or their assignees.
- If exercised by the debtor, the creditor would no longer have recourse to any other assets or income of the debtor beyond the pledged collateral in case of any deficiency claim.
- Retroactive application: the law applies not only to new loans but also to existing ones, including situations where property was foreclosed in the past or foreclosure proceedings are ongoing.
- The law does not specify other economic or eligibility criteria for borrowers and does not appear to take into account the borrower’s ability to pay.

### Legal and institutional concerns
- Romanian banks and the National Bank of Romania (NBR) argue that some provisions can create legal uncertainties, moral hazard, and may pose systemic risk to banks.
- The European Central Bank (ECB) noted that the draft law introduces unprecedented changes into the legal framework applicable to credit agreements in Romania and will significantly undermine legal certainty and the adequate management of credit risk in financial institutions (ECB opinion of December 18, 2015).
- The European Commission (EC) has also expressed major concerns including regarding the retroactive applicability of the law.

### Quantitative estimates of potential impact
- Amount of overdue loans eligible for application under the law is around RON 5 billion — cited as a potential lower limit of the amount banks would have to write off (write-offs would be smaller by the amount of provisions for overdue loans; such provision data was not available).
- “Underwater mortgage” scenario: a hypothetical assumption of 20 percent of total loans being loans where borrowers decide to take advantage of the law would add RON 8 billion to possible write-offs.
- Combined range for potential write-offs: RON 5–13 billion.
- Asset-sale loss assumption: applying an assumption that banks incur a loss of 25 percent of the loan value when they sell the underlying immovable property yields an overall loss to banks in the range of RON 1.3–3.3 billion.
- The estimated overall loss could be up to 4 percent of commercial banks total capital.
- Estimates could be higher if there is significant use of the law.

### Additional operational and systemic risks
- Banks will incur additional operational expenses to manage and sell portfolios of immovable property taken onto balance sheets.
- Key negative spillovers highlighted:
  - Undermining future credit expansion and investor confidence by making the legal framework less predictable.
  - Risks of contingent liabilities for the state if banks pursue compensation claims against the Romanian state in courts.

### Policy implications and considerations
- The law’s retroactive and unilateral contract changes create legal uncertainty and impair adequate management of credit risk in financial institutions.
- Potential fiscal and financial stability implications warrant careful consideration of legal design, scope, and safeguards to avoid large write-offs, operational burdens on banks, and adverse effects on credit access and investor confidence.

*Source: IMF staff summary of Box 2, "Debt Discharge (Giving in Payment) Law."*

### Annex I. Implementation of the 2015 Article IV Key

### Annex I. Implementation of the 2015 Article IV Key Recommendations

### Key recommendations and policy actions
- Maintain fiscal adjustment achievements and put public debt as a share of GDP on a downward path
  - 2015 fiscal deficit lower than targeted and public debt as a share of GDP declined, but 2016 budget envisages a substantially higher deficit raising the public debt ratio.
- Improve revenue administration
  - Several administrative measures implemented that have strengthened tax collection (compared to a weak base though). Nonetheless, tax collection gap remains substantial.
- Improve public expenditure management including through higher EU funds absorption
  - Tighter scrutiny of the selection of domestically financed investment projects and higher EU funds absorption, though far less than envisaged. Limited progress toward better investment planning and execution.
- Maintain easing bias and improve monetary policy framework
  - Policy eased throughout 2015. Interest rate corridor around policy rate narrowed, interventions in the foreign exchange market became more limited, and during last months of the year exchange rate became more flexible.
- Continue intense watch on the banking and insurance sectors with a focus on better assessment of asset quality
  - Implemented a balance sheet review of major insurance companies. Initiated process to conduct an asset quality review for major banks. Continued close bank supervision.
- Create effective insolvency frameworks
  - Personal insolvency law adopted but enforcement delayed by one year amid lack of development of effective secondary legislation and institutions.
- Reduce non-performing loans (NPL)
  - Continued efforts towards further NPL reduction and a sharp recent reduction in the NPL ratio.
- Further deregulate energy markets
  - Implemented the gas price deregulation for non-residential consumers. Continued implementation of electricity market deregulation.
- Improve financial performance of state-owned enterprise (SOE) sector through better governance and restructuring
  - Improvement in overall financial situation, albeit to varying degrees across the sector. Weak implementation of the SOE corporate governance law. Strengthened legislation prepared in line with IFIs recommendations still to be adopted.
- Increase private ownership in SOEs
  - Pursuit of majority privatization attempts of SOEs and initial public offerings unsuccessful.

### Risk Assessment Matrix — selected risks, likelihood, transmission, impact, and policy responses
- 1. Tighter or more volatile global financial conditions
  - Relative Likelihood: Medium
  - Transmission channels: Investors may sell Romanian financial assets after reassessment of risks and increases in U.S. term premia; increase in borrowing costs; risk of exchange rate overshooting and financial instability.
  - Expected impact if realized: Medium
  - Policy response: Utilize some of fiscal financing buffer until markets settle down; allow for exchange rate flexibility while offsetting excessive market volatility.
- 2. A further deterioration in the fiscal balance above the targeted budget
  - Relative Likelihood: Medium
  - Transmission channels: Loss of recently built fiscal credibility and associated worsening of market sentiment; Romania enters EU's Excessive Deficit Procedure and public debt rises; borrowing costs increase and private investment is crowded out weighing on growth prospects.
  - Expected impact if realized: Medium
  - Policy response: Reverse tax cuts, restrain future wage increases, cut lower priority expenditure; improve tax administration to raise more revenues.
- 3. Persistent shortfall in public investment including through weak EU funds absorption
  - Relative Likelihood: High
  - Transmission channels: Bottlenecks in public administration continue to hamper public investment and EU funds absorption; delay in much-needed infrastructure upgrade would constrain growth prospects.
  - Expected impact if realized: Medium
  - Policy response: Improve EU projects implementation capacity; improve investment prioritization, strengthen public investment review process, improve procurement framework.
- 4. Adoption of potentially harmful legislation for financial sector
  - Relative Likelihood: Medium
  - Transmission channels: Laws are adopted that contain retroactive and unilateral change of loan contracts; commercial banks incur substantial losses; undermines future credit expansion and investor confidence by making the legal framework less predictable.
  - Expected impact if realized: Medium
  - Policy response: Intervene by providing liquidity to solvent banks that come under financial stress.
- 5. Sharper-than-expected global growth slowdown
  - Relative Likelihood: Medium
  - Transmission channels: Exports could fall, particularly if the euro area enters into a protracted period of slower growth; FDI could drop as investors reassess future euro area demand for Romanian exports.
  - Expected impact if realized: Medium
  - Policy response: Allow limited use of automatic stabilizers to work as a sharp fiscal deterioration could worsen market sentiment; accelerate absorption of EU funds; allow for exchange rate flexibility while offsetting excessive market volatility.
- 6. Persistently lower energy prices and low inflation in euro area
  - Relative Likelihood: High
  - Transmission channels: Low energy prices and imported euro area low inflation pass through to the overall price level; deflation lasts longer and inflation stays below target in the medium term; inflation expectations fall leading to their de-anchoring from inflation target; domestic demand gets a boost from higher real incomes and lower production costs; oil and gas producing companies cut investments, jobs and tax payments.
  - Expected impact if realized: Low/Medium
  - Policy response: Ease monetary policy if deflationary pressures materialize; strengthen policy communication to anchor inflation expectations.

### Debt Sustainability Analysis — public debt: baseline and risks
- Baseline macro-fiscal assumptions
  - Output gap: expected to be slightly positive in 2016–18 and to be closed by 2021.
  - Real growth: close to 4 percent in 2016 and stabilize at slightly above 3 percent afterwards.
  - Fiscal balance: projected to deteriorate from 1.5 percent in 2015 to 2.8 percent (in cash terms; close to 3 percent in ESA terms) in 2016 and to remain close to 3 percent afterwards up until 2021.
  - Three years average level of the cyclically adjusted primary balance in 2016: slightly negative; maximum adjustment over a three-year horizon starting from 2016: close to zero.
- Public debt levels and composition
  - Public debt, including guarantees, is estimated at 39.3 percent of GDP in 2015.
  - Projected to increase to about 42 percent by 2021.
  - Gross financing needs: projected to remain rather stable at about 8 percent of GDP over the projection horizon.
  - Foreign currency financing buffer (excluding privatization proceeds): about 3.3 percent of GDP or almost five months of gross financing needs.
  - Most longer-term debt: official financing.
  - Average maturity of government securities issued on the domestic market: about three years.
  - Foreign currency denominated debt: about 55 percent of public debt.
  - Non-residents share in domestic debt securities holdings: about 20 percent.
  - SOE debt (including SOEs under insolvency procedures): around 7.5 percent of GDP.
- Stress tests and risks
  - Weaker GDP growth could push the debt ratio to 55 percent of GDP by 2021.
  - A combination of adverse macro shocks could push the debt above 60 percent threshold of the Stability and Growth Pact by 2020 (though below the 70 percent DSA benchmark).
  - Risks from known contingent liabilities are contained since all outstanding guarantees are already included in public debt and banks are well capitalized with limited exposure to short-term external debt.
- External debt and current account
  - Projected medium-term current account deficit: 3.5 percent of GDP.
  - Current account deficit adjusted from 11.8 percent of GDP in 2008 to 1.1 percent of GDP in 2015.
  - External debt at end-2015: gross external debt at 56.7 percent of GDP at end-2015, 6.4 percentage points below 2014.
  - Around one-third of external debt stock was public debt.
  - Almost one-fifth of external debt was at short-term maturities, mainly of the non-bank sector.
  - Short-term financing risk for non-bank private sector expected to be limited as a substantial portion of the short-term debt is intra-company loans with relatively low rollover risks.
  - External debt as a share of GDP expected to rise in 2016 by 2 percentage points, mainly due to the increase in private debt, but then gradually fall from 2017.
  - Vulnerability: a 30 percent currency depreciation shock would substantially increase the external debt-to-GDP ratio over the medium term.

### Public Sector DSA — baseline projections (selected figures, "As of March 29, 2016")
- Nominal gross public debt (in percent of GDP): 2014: 24.5; 2015: 40.5; 2016: 39.3; 2017: 39.8; 2018: 40.3; 2019: 40.8; 2020: 41.9; 2021: 43.0; cumulative 44.2.
- Of which: guarantees (in percent of GDP): 2014: 2.6; 2015: 2.4; 2016: 2.3; 2017: 2.1; 2018: 2.0; 2019: 1.9; 2020: 1.8; 2021: 1.7; 1.6.
- Public gross financing needs (in percent of GDP): 2014: 9.7; 2015: 9.1; 2016: 8.6; 2017: 8.7; 2018: 8.8; 2019: 7.0; 2020: 7.4; 2021: 7.5; 7.6; 5.6.
- Real GDP growth (in percent): 2014: 2.8; 2015: 3.0; 2016: 3.8; 2017: 4.2; 2018: 3.6; 2019: 3.3; 2020: 3.3; 2021: 3.3.
- Inflation (GDP deflator, in percent): 2014: 8.2; 2015: 1.7; 2016: 2.9; 2017: 1.9; 2018: 2.3; 2019: 2.7; 2020: 2.3; 2021: 2.3; 2.5.
- Nominal GDP growth (in percent): 2014: 11.4; 2015: 4.7; 2016: 6.8; 2017: 6.2; 2018: 6.0; 2019: 6.0; 2020: 5.6; 2021: 5.7; 5.8.
- Effective interest rate (in percent): 2014: 7.5; 2015: 4.4; 2016: 3.8; 2017: 3.9; 2018: 4.0; 2019: 4.1; 2020: 3.9; 2021: 4.0; 4.2.
- Change in gross public sector debt (in percent of GDP, annual): 2014: 2.0; 2015: 1.7; 2016: -1.2; 2017: 0.5; 2018: 0.5; 2019: 0.5; 2020: 1.1; 2021: 1.1; cumulative: 2.4; 4.9.
- Identified debt-creating flows (in percent of GDP, cumulative): 2.1; 4.2; 3.2; 1.0; 0.4; 0.4; 0.6; 0.7; 0.7; 3.9.
- Primary deficit (in percent of GDP): 2014: 2.5; 2015: 0.4; 2016: 0.2; 2017: 1.5; 2018: 1.3; 2019: 1.2; 2020: 1.3; 2021: 1.4; cumulative: 1.8; 8.0.
- Primary (noninterest) revenue and grants (in percent of GDP, cumulative to 2021): 31.6; 32.0; 32.7; 30.6; 29.5; 29.0; 28.9; 28.8; 28.6; 175.4.
- Primary (noninterest) expenditure (in percent of GDP, cumulative to 2021): 34.1; 32.4; 32.9; 32.0; 30.8; 30.2; 30.2; 30.2; 30.0; 183.4.
- Automatic debt dynamics contribution (percent of GDP): -0.3; 2.9; 1.7; -0.9; -0.8; -0.7; -0.7; -0.7; -0.6; -4.4.
- Real interest rate contribution (percent): 0.0; 1.0; 0.3; 0.7; 0.6; 0.5; 0.6; 0.6; 0.7; 3.7.
- Real GDP growth contribution (percent): -0.5; -1.1; -1.4; -1.6; -1.4; -1.2; -1.3; -1.3; -1.3; -8.0.
- Exchange rate depreciation contribution (percent): 0.2; 3.0; 2.9.
- Other identified debt-creating flows (percent of GDP): 0.0; 1.0; 1.2; 0.4; -0.2; 0.0; 0.0; 0.0; 0.0; 0.3.
- Privatization receipts (negative, percent of GDP): -0.2; 0.0; 0.0; 0.0; 0.0; 0.0; 0.0; 0.0; 0.0; 0.0.
- Increase in deposits (percent of GDP): 0.2; 1.0; 1.2; 0.4; -0.1; 0.0; 0.0; 0.0; 0.0; 0.3.
- Residual, including asset changes (percent of GDP): -0.1; -2.6; -4.4; -0.5; 0.1; 0.0; 0.5; 0.4; 0.5; 1.1.

*Annex I. Implementation of the 2015 Article IV Key Recommendations*

### Annex III. Figure 4. Romania Public DSA—Composition of Public Debt and Alternative Scenarios

### Annex III. Figure 4. Romania Public DSA—Composition of Public Debt and Alternative Scenarios

### Baseline and Alternative Scenario Assumptions
- Baseline real GDP growth: 2016: 4.2; 2017: 3.6; 2018: 3.3; 2019: 3.3; 2020: 3.3; 2021: 3.3
- Baseline inflation: 2016: 1.9; 2017: 2.3; 2018: 2.7; 2019: 2.3; 2020: 2.3; 2021: 2.5
- Baseline primary balance (percent of GDP): 2016: -1.5; 2017: -1.3; 2018: -1.2; 2019: -1.3; 2020: -1.4; 2021: -1.4
- Baseline effective interest rate: 2016: 3.9; 2017: 4.0; 2018: 4.1; 2019: 3.9; 2020: 4.0; 2021: 4.2

- Historical scenario real GDP growth: 2016: 4.2; 2017: 2.7; 2018: 2.7; 2019: 2.7; 2020: 2.7; 2021: 2.7
- Historical scenario primary balance: 2016: -1.5; 2017: -2.3; 2018: -2.3; 2019: -2.3; 2020: -2.3; 2021: -2.3
- Historical scenario effective interest rate (note 1/): 2016: 3.9; 2017: 3.9; 2018: 3.7; 2019: 3.4; 2020: 3.3; 2021: 3.4
  - 1/ Declining effective interest rate reflects negative historical real interest rates in Romania during the reference period.

- Constant Primary Balance scenario primary balance: -1.5 for 2016–2021
- Constant Primary Balance effective interest rate: 2016: 3.9; 2017: 3.9; 2018: 4.0; 2019: 3.9; 2020: 4.0; 2021: 4.3

- Contingent Liability Shock scenario primary balance: 2016: -1.5; 2017: -1.3; 2018: -1.2; 2019: -1.3; 2020: -1.4; 2021: -1.4
- Contingent Liability Shock effective interest rate: 2016: 3.9; 2017: 4.5; 2018: 4.1; 2019: 3.9; 2020: 4.1; 2021: 4.3

- Customized shock 1 assumptions:
  - Real GDP growth: 2016: 4.2; 2017: 1.6; 2018: 1.3; 2019: 1.3; 2020: 1.3; 2021: 1.3
  - Inflation: 2016: 1.9; 2017: 2.3; 2018: 2.7; 2019: 2.3; 2020: 2.3; 2021: 2.5
  - Primary balance: 2016: -1.5; 2017: -3.3; 2018: -3.2; 2019: -3.3; 2020: -3.4; 2021: -3.4
  - Effective interest rate: 2016: 3.9; 2017: 3.9; 2018: 4.1; 2019: 4.0; 2020: 4.2; 2021: 4.5

### Composition and Key Public Debt Indicators (figures referenced)
- Gross nominal public debt tracked as percent of GDP for 2014–2021 (projection period indicated).
- Public gross financing needs tracked as percent of GDP for 2014–2021 (projection period indicated).
- By maturity (2005–2021 historical and projection): medium and long-term vs short-term shares (in percent of GDP).
- By currency (2005–2021 historical and projection): local currency-denominated vs foreign currency-denominated shares (in percent of GDP).

*Source: IMF staff.*

---

### Annex III. Figure 5. Romania Public DSA—Stress Tests

### Stress Test Assumptions and Paths (selected scenarios)
- Baseline real GDP growth: 2016: 4.2; 2017: 3.6; 2018: 3.3; 2019: 3.3; 2020: 3.3; 2021: 3.3
- Baseline inflation: 2016: 1.9; 2017: 2.3; 2018: 2.7; 2019: 2.3; 2020: 2.3; 2021: 2.5
- Baseline primary balance: 2016: -1.5; 2017: -1.3; 2018: -1.2; 2019: -1.3; 2020: -1.4; 2021: -1.4
- Baseline effective interest rate: 2016: 3.9; 2017: 3.9; 2018: 4.1; 2019: 4.0; 2020: 4.1; 2021: 4.3

- Primary Balance Shock path:
  - Real GDP growth identical to baseline.
  - Primary balance: 2016: -1.5; 2017: -2.4; 2018: -2.2; 2019: -1.3; 2020: -1.4; 2021: -1.4
  - Effective interest rate: 2016: 3.9; 2017: 3.9; 2018: 4.1; 2019: 4.0; 2020: 4.1; 2021: 4.3

- Real GDP Growth Shock path:
  - Real GDP growth: 2016: 4.2; 2017: -1.1; 2018: -1.4; 2019: 3.3; 2020: 3.3; 2021: 3.3
  - Inflation: 2016: 1.9; 2017: 1.1; 2018: 1.5; 2019: 2.3; 2020: 2.3; 2021: 2.5
  - Primary balance: 2016: -1.5; 2017: -3.1; 2018: -4.9; 2019: -1.3; 2020: -1.4; 2021: -1.4
  - Effective interest rate: 2016: 3.9; 2017: 3.9; 2018: 4.2; 2019: 4.2; 2020: 4.3; 2021: 4.5

- Real Interest Rate Shock path:
  - Effective interest rate: 2016: 3.9; 2017: 3.9; 2018: 4.8; 2019: 5.0; 2020: 5.6; 2021: 6.2

- Real Exchange Rate Shock path:
  - Inflation: 2016: 1.9; 2017: 8.1; 2018: 2.7; 2019: 2.3; 2020: 2.3; 2021: 2.5
  - Effective interest rate: 2016: 3.9; 2017: 4.3; 2018: 4.0; 2019: 3.8; 2020: 3.9; 2021: 4.2

- Combined Shock (Real GDP Growth + others):
  - Real GDP growth: 2016: 4.2; 2017: -1.1; 2018: -1.4; 2019: 3.3; 2020: 3.3; 2021: 3.3
  - Inflation: 2016: 1.9; 2017: 1.1; 2018: 1.5; 2019: 2.3; 2020: 2.3; 2021: 2.5
  - Primary balance: 2016: -1.5; 2017: -3.1; 2018: -4.9; 2019: -1.3; 2020: -1.4; 2021: -1.4
  - Effective interest rate: 2016: 3.9; 2017: 4.3; 2018: 4.7; 2019: 5.2; 2020: 5.7; 2021: 6.3

### Stress Test Outputs (figure references)
- Gross nominal public debt tracked (in percent of GDP) under baseline and each stress scenario for 2016–2021.
- Gross nominal public debt tracked (in percent of Revenue) under baseline and stress scenarios for 2016–2021.
- Public gross financing needs tracked (in percent of GDP) under baseline and stress scenarios for 2016–2021.

*Source: IMF staff.*

---

### Annex III. Figure 6 and Annex III. Table 1. External Debt Sustainability and Key External Indicators

### External debt bound tests (figure notes)
- Individual shocks are permanent one-half standard deviation shocks.
- Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance.
- One-time real depreciation of 30 percent occurs in 2013 (noted in figures).

### Selected table highlights (External Debt Sustainability Framework, 2011–21; in percent of GDP unless indicated)
- Baseline: External debt series (Est. and projections): 2011: 74.0; 2012: 74.6; 2013: 68.0; 2014: 63.1; 2015: 56.7; 2016: 58.7; 2017: 56.6; 2018: 52.7; 2019: 48.9; 2020: 45.6; 2021: 42.4
- Debt-stabilizing non-interest current account: -2.8
- Change in external debt: 2011: 1.1; 2012: 0.6; 2013: -6.6; 2014: -4.9; 2015: -6.4; 2016: 2.0; 2017: -2.1; 2018: -3.9; 2019: -3.8; 2020: -3.3; 2021: -3.2
- Identified external debt-creating flows (4+8+9): 2011: 0.0; 2012: 2.6; 2013: -6.4; 2014: -4.0; 2015: -4.5; 2016: -2.2; 2017: -1.3; 2018: -0.8; 2019: -0.4; 2020: 0.1; 2021: 0.3

- Current account deficit, excluding interest payments: 2011: 2.2; 2012: 2.3; 2013: -1.6; 2014: -1.6; 2015: -0.6; 2016: -1.0; 2017: 0.5; 2018: 0.8; 2019: 1.3; 2020: 1.8; 2021: 2.0
- Deficit in balance of goods and services: 2011: 5.8; 2012: 5.1; 2013: 0.8; 2014: 0.3; 2015: 0.5; 2016: 1.7; 2017: 2.4; 2018: 2.5; 2019: 2.7; 2020: 3.0; 2021: 3.1

- Exports (percent of GDP): 2011: 36.6; 2012: 37.3; 2013: 39.7; 2014: 41.2; 2015: 41.1; 2016: 39.1; 2017: 39.6; 2018: 40.3; 2019: 40.8; 2020: 41.5; 2021: 41.9
- Imports (percent of GDP): 2011: 42.4; 2012: 42.3; 2013: 40.5; 2014: 41.5; 2015: 41.6; 2016: 40.8; 2017: 42.0; 2018: 42.8; 2019: 43.5; 2020: 44.4; 2021: 45.0

- Net non-debt creating capital inflows (negative): 2011: -1.4; 2012: -2.1; 2013: -1.9; 2014: -1.7; 2015: -1.6; 2016: -1.7; 2017: -1.8; 2018: -1.8; 2019: -1.8; 2020: -1.8; 2021: -1.8

- Automatic debt dynamics (contribution, percent of GDP): 2011: -0.9; 2012: 2.3; 2013: -2.9; 2014: -0.7; 2015: -2.3; 2016: 0.4; 2017: 0.0; 2018: 0.1; 2019: 0.1; 2020: 0.1; 2021: 0.1
  - Contribution from nominal interest rate: 2011: 2.7; 2012: 2.5; 2013: 2.6; 2014: 2.0; 2015: 1.7; 2016: 2.7; 2017: 2.0; 2018: 1.9; 2019: 1.7; 2020: 1.6; 2021: 1.5
  - Contribution from real GDP growth: 2011: -0.7; 2012: -0.5; 2013: -2.4; 2014: -1.9; 2015: -2.2; 2016: -2.3; 2017: -2.0; 2018: -1.7; 2019: -1.6; 2020: -1.5; 2021: -1.4
  - Contribution from price and exchange rate changes: 2011: -2.8; 2012: 0.3; 2013: -3.1; 2014: -0.8; 2015: -1.8 (remaining entries not shown)

- Residual, incl. change in gross foreign assets (2-3): 2011: 1.2; 2012: -2.0; 2013: -0.2; 2014: -1.0; 2015: -1.9; 2016: 4.3; 2017: -0.9; 2018: -3.1; 2019: -3.4; 2020: -3.4; 2021: -3.5

- External debt-to-exports ratio (in percent): 2011: 202.3; 2012: 200.2; 2013: 171.1; 2014: 153.0; 2015: 137.9; 2016: 150.1; 2017: 143.0; 2018: 130.8; 2019: 119.8; 2020: 110.0; 2021: 101.1

- Gross external financing need (in billions of Euros): 2011: 38.9; 2012: 45.2; 2013: 45.6; 2014: 41.6; 2015: 42.0; 2016: 42.5; 2017: 41.7; 2018: 44.0; 2019: 44.5; 2020: 45.1; 2021: 43.8
  - in percent of GDP: 2011: 29.2; 2012: 33.9; 2013: 31.6; 2014: 27.7; 2015: 26.2; 2016: 25.4; 2017: 23.5; 2018: 23.3; 2019: 22.3; 2020: 21.4; 2021: 19.6

### Key macroeconomic baseline assumptions (selected)
- Real GDP growth (in percent): 2011: 1.1; 2012: 0.6; 2013: 3.5; 2014: 3.0; 2015: 3.8; 2016: 2.7; 2017: 4.7; 2018: 4.2; 2019: 3.6; 2020: 3.3; 2021: 3.3; 2022: 3.3; 2023: 3.3 (table spans multiple years; entries shown above)
- GDP deflator in Euros (change in percent): 2011: 4.0; 2012: -0.4; 2013: 4.3; 2014: 1.1; 2015: 2.9; 2016: 4.7; 2017: 7.8; 2018: 0.2; 2019: 2.4; 2020: 2.8; 2021: 2.4; 2022: 2.5; 2023: 2.6
- Nominal external interest rate (in percent): 2011: 3.9; 2012: 3.3; 2013: 3.8; 2014: 3.1; 2015: 2.9; 2016: 4.1; 2017: 1.0; 2018: 5.0; 2019: 3.6; 2020: 3.5; 2021: 3.5; 2022: 3.5; 2023: 3.5

*Sources: International Monetary Fund, Country desk data, and staff estimates.*

---

### Annex IV. External Sector Assessment — Key Findings

### Overall assessment
- Staff’s overall assessment: Romania’s external position in 2015 was broadly in line with fundamentals.

### Foreign assets and liabilities
- Net international investment position (IIP) in 2015: -50.2 percent of GDP
- Improvement since 2014: 6.7 percentage points (improvement due to decrease in foreign liabilities)
- Outlook: IIP expected to continue to improve, driven mainly by continued reduction in external liabilities.

### Current account
- Current account deficit narrowing since 2008: from 11.8 percent of GDP in 2008 to 1.1 percent in 2015.
- Exports of goods and services comprise around 40 percent of GDP (pre-crisis level was 25 percent of GDP).
- The deficit modestly deteriorated in the last year due to increase in goods deficit and near-doubling of primary income deficit.
- EBA-lite cyclically-adjusted CA norm: -3.0 percent of GDP.
- EBA-lite estimated CA gap: 2.0 percent (including policy gap of 0.9 percent, mainly due to the fiscal gap in the rest of the world).
- Staff view: EBA-lite does not fully capture temporary factors; current account deficit expected to gradually widen to 3.5 percent in the medium term.
- Staff assesses cyclically-adjusted CA removing temporary factors would be around -2 percent of GDP, implying underlying cyclically-adjusted CA is lower than the cyclically-adjusted norm.

### Real exchange rate
- Real exchange rate depreciated by around 4 percent in 2015.
- EBA-Lite CA model: appreciation of around 8 percent needed to close gap between underlying cyclically-adjusted CA and norm (if exchange rate is primary driver).
- Staff assessment: appreciation of around 4 percent required to close CA gap when temporary factors considered.
- EBA-Lite REER index model suggests modest undervaluation: -2 percent.
- EBA-Lite External Sustainability Approach suggests undervaluation: -3.6 percent.
- Overall staff assessment: real exchange rate broadly in line with equilibrium.
- Risk: recent wage pressure — average increase of 8 percent in 2015 (due to rise in public wages and minimum wages) could undermine competitiveness.

### Reserve adequacy
- Reserve level at end-December 2015: €35.5 billion.
- Reserves above standard rules of thumb: three months coverage of prospective imports and 20 percent of broad money.
- Reserves in line with new reserve adequacy metric for emerging markets developed by Fund staff.
- Reserves slightly short of 100 percent short-term debt benchmark (at remaining maturity), but metric improved due to reduction in short-term external liabilities.
- Policy implication: in light of continued downside external risks, a prudent stance with moderate reserve accumulation remains appropriate.

*Source: IMF staff.*

---

### Annex V. Fiscal Institutions — Key Findings and Institutional Gaps

### Fiscal rules and framework
- Romania’s fiscal rules follow the EU model; 2010 Fiscal Responsibility Law (FRL) amended in 2013 to include structural fiscal targets and corrective actions.
- Medium-Term Objective (MTO): 1 percent of GDP deficit, to be achieved through structural annual adjustments of 0.5 percent of GDP.
- Annual increase of expenditures should not exceed projected nominal GDP growth for the next three years until budget balance is in surplus.
- Public debt ceiling: 60 percent of GDP.
- Municipalities: budgets must be balanced excluding loans for investment and debt refinancing; municipalities cannot contract or guarantee loans if annual public debt service (principal, interest, commissions) including new loan exceeds 30 percent of their own revenue.

### Institutions and enforcement
- Fiscal Council established mid-2010; issues opinions and recommendations on macro and budgetary forecasts, annual budget laws, and assesses compliance of medium-term fiscal strategy with FRL.
- European Commission 2014 assessment indicators show general government rules fare well; local level has room for improvement in enforcement mechanisms and media visibility.

### Implementation challenges
- Actual enforcement of rules is weak; rules have been repeatedly circumvented.
- Example: 2016 budget law breached the fiscal rule and contained provisions to waive the FRL, avoiding triggering automatic sanctions.
- Recommendations to strengthen effectiveness:
  - Increase public awareness of the rules.
  - Ensure proper tracking of risk of breaching the rules.
  - Strengthen automatic sanctions to incentivize responsible parties to apply the rules.

*Source: IMF staff.*

---

### Annex VI. Inflation Outlook in Romania — Key Points

### Recent inflation developments
- Headline inflation declined markedly in recent years; fell below the target in 2014 and entered negative territory in June 2015.
- Direct inflation targeting introduced in August 2005; inflation close to, though mostly slightly above, target range prior to recent declines.

### Drivers of the fall in inflation
- Key factors: oil and food price developments and reduction in VAT rate.
- Three episodes of notable inflation decline:
  - Mid-2013: lower food prices after abundant harvest and reduction in VAT on some food products.
  - Since autumn 2014: declining international energy prices.
  - Mid-2015 and January 2016: VAT reductions — VAT rate reduction on food items from 24 to 9 percent in mid-2015 and standard VAT rate reduction from 24 to 20 percent in January 2016 — key reasons inflation turned negative.

*Source: IMF staff.*

### 3.      Despite the fall in headline inflation,

### _cr16113 - 3.      Despite the fall in headline inflation,

### Inflation developments and recent drivers
- Headline inflation in the first half of this year is expected to fall lower, following:
  - the recent standard VAT rate reduction (from 24 to 20 percent),
  - lower import prices,
  - the decrease of tariffs for electricity.
- Underlying inflation—adjusted for the VAT cut but nevertheless incorporating lower international food and energy prices—has been rising in recent months and reached 2.3 percent in December 2015 (HICP at constant tax, Eurostat estimate).
- Based on the latest projections by the NBR, underlying inflation is projected to reach 3.7 percent by end-2017.
- Consensus forecasts for 2017 and 2018 have stayed close to the target.

### Contributions and composition
- Headline Inflation—Contributions by Components (HICP/HICP at constant tax):
  - Overall index excluding energy, food, alcohol and tobacco, Food, Alcoholic beverages, tobacco and narcotics, Energy components shown (percent, annual inflation) as per Eurostat and IMF staff calculations.
- Inflation expectations are reported as close to target.

### Risks, demand pressures, and outlook
- Going forward, domestic factors pointing to a potential buildup of inflationary pressure include:
  - The output gap is projected to turn positive this year, as Romanian economic growth is set to accelerate.
  - Wage pressure is growing, following the announced, large-scale upward adjustment in minimum wages and public wages.
  - The fiscal impulse of about 2 percent of GDP is likely to drive up inflation expectations.
  - Supply shocks that have been lowering inflation (notably lower international food and energy prices) would likely reverse or phase out over the next 12 months.

### Annex VII — Minimum Wage Policy in Romania: findings
- Recent changes and magnitude:
  - Minimum wages will be raised in May 2016, resulting in about 78.6 percent increase compared to end-2012.
  - With the planned increase in 2016, the minimum wage in Romania would leap to approximately 45.3 percent of mean wage and 65.4 percent of median wage.
- Incidence and distribution:
  - In 2013, there were approximately 430,000 workers in Romania with wages at or below the minimum wage, accounting for about 11.2 percent of total workers registered.
  - Minimum wage workers are largely concentrated in construction, trade, manufacturing, hotels and restaurants.
  - The majority of these workers are among working-age group and about two-thirds of minimum wage workers are male.
  - There was only 0.5 percent of government employees who received minimum wage in 2013, and a large increase in public sector wage in 2016 would lift the monthly salary for all government employees above the minimum wage.
- Policy intent and targeting:
  - The increase in minimum wage is aimed at reducing poverty as part of measures committed in the Europe strategy 2020.
  - The share of workers at or below the minimum wage rose to 11.3 percent after the first hike in 2013, from around 4 percent in 2012.
  - Minimum wage is a poorly targeted instrument and may not be effective in reducing poverty as the effects depend on the overlap between minimum wage earners and the working poor (IMF Country Report No. 14/221 and OCED (2015)).
- Potential adverse effects and labor-market considerations:
  - Several studies find that high minimum wage to gross average wage ratio could undermine external competitiveness and export performance, while hampering potential foreign direct investment that could benefit low-skilled labor.
  - Minimum wage is, in principle, a wage floor. If the floor is set too high, it could affect firms’ profitability and discourage employers from hiring.
  - Studies generally find negative labor demand elasticity to the change in minimum wage, particularly among young or low-skilled workers.
  - The net effect on total employment may vary depending on overall economic conditions and labor market structures across countries.
  - Sharp and sudden minimum wage increases are more often associated with sizeable employment effects, particularly if the initial level of minimum to average wage ratio is already at high level.

*Source: IMF staff text as presented in the provided document.*

### 4.      Future decisions on minimum wage need to be carefully crafted. The International Labor

### _cr16113 - 4.      Future decisions on minimum wage need to be carefully crafted. The International Labor

### ILO guidance and criteria
- The International Labor Organization (ILO) Convention on Minimum Wage Fixing (1970) suggests several elements to be taken into consideration in determining the level of minimum wages:
  - (a) the needs of workers and their families
  - (b) economic factors including the requirements of economic development, levels of productivity and the desirability of attaining and maintaining a high level of employment

### Current institutional practice in Romania
- Minimum wage in Romania is determined at the national level by the government after consulting trade unions and employers’ organizations.

### Economic risks and contextual assessment
- Minimum-to-average wage ratios in Romania are already higher than its peers, which means future increases:
  - could weigh on Romania’s perceived competitiveness in the region
  - could have adverse economic effects if increases are unsustainably rapid

### Policy recommendations and procedural safeguards
- Future minimum wage adjustments could usefully be based on a transparent and clear mechanism.
- Avoid unsustainably rapid increases to minimize adverse effects on competitiveness and employment.
- Periodic assessments of the impact of labor market policy, including minimum wages, by labor market expert committees could usefully inform future policy decisions.

*Source: ROMANIA STAFF REPORT FOR THE 2016 ARTICLE IV CONSULTATION—INFORMATIONAL ANNEX*

### 8.8 percent. The inflation rate had a positive evolution during the last years. Since 2013,

### _cr16113 - 8.8 percent. The inflation rate had a positive evolution during the last years. Since 2013,

### Inflation
- "8.8 percent." (opening figure as presented in the source.)
- Since 2013, when the central bank brought inflation back within the target range, it has been on a descending path.
- At the end of 2015, the annual CPI inflation rate continued to stay under the lower bound of the ±1 percentage point variation band of the 2.5 percent flat target.
- Under the current baseline scenario:
  - the annual CPI inflation is projected to remain negative but later this year would return to positive levels, below the lower bound of the variation band of the target.
  - The inflation rate is expected to reenter the variation band at the beginning of 2017 and stay there until the projection horizon, when it is seen reaching 3.4 percent.

### External position
- The external position has improved markedly.
- The current account deficit adjusted remarkably since the global financial crisis (1.1 percent) and registered a modest widening in 2015.
- Romania continued and improved its presence on international capital markets, thus generating significant buffers.
- FDI inflows improved moderately due to the reinvestment of earnings and the economic recovery.
- Despite large repayments to the Fund and the EU, gross reserves of €35.5 billion at end-2015 are broadly adequate by most reserve adequacy metrics.
- The economy remains vulnerable to adverse developments in international markets; authorities will remain vigilant, act proactively, and take the necessary steps to contain these risks.

### Fiscal sector and public finances
- Significant progress continued in the fiscal sector but challenges remain.
- Since the start of the first program, Romania improved its fiscal position and reduced fiscal imbalances.
- In 2015, the fiscal deficit went below 1.5 percent of GDP, from almost 9 percent in 2008.
- Following legislation adopted in late 2015:
  - a package of tax cuts costing 1.4 percent of GDP in 2016 and a further 0.8 percent of GDP in 2017 poses significant fiscal challenges.
  - The new Fiscal Code involves a welcome simplification of taxation legislation and has measures with positive revenue effects, including base broadening of social security contributions.
  - These measures are aimed at stimulating the economy and incentivizing shifts from the informal to the formal sector.
- Authorities are committed to:
  - continued improvement of revenue collection,
  - maintaining the fiscal deficit at 2.8 percent for 2016,
  - continuing sound fiscal policies and stronger public financial management.
- Recent actions:
  - progress with prioritization of large public investment projects,
  - significant steps to enhance transparency of spending of public entities,
  - government plans to widen the use of centralized procurement.
- Authorities are aware of existing challenges and committed to pursue measures for fiscal sustainability and good public financial management.

### Monetary policy and central bank actions
- The National Bank of Romania (NBR) continued the rate-cutting cycle, lowering the policy rate to 1.75 percent.
- Measures were accompanied by a narrowing of the interest rate corridor and lowering the rate of minimum reserve requirement on both local and foreign exchange denominated liabilities.
- The central bank will ensure adequate liquidity conditions in the banking system, while underpinning the good functioning of money markets.
- The monetary authorities consider that consistent implementation of an adequate macroeconomic policy mix and the step up in structural reforms, along the lines of the external financing arrangements, together with:
  - sustainable financial intermediation and
  - an appropriate remuneration of bank deposits,
  are pivotal to consolidating the Romanian economy and enhancing its resilience to external shocks.

### Financial sector stability
- The financial sector in Romania has strengthened in recent years.
- In 2015:
  - banks’ profitability reverted to positive territory,
  - high solvency and liquidity ratios were reported,
  - the non-performing loan ratio was on a downward path.
- Contagion risks declined as reliance of banks in Romania on parent bank funding decreased.
- The comprehensive action plan of the central bank consisting of NPLs sales, write-offs and higher provisioning helped NPLs to further decline to 11.65 percent at end-2015.
- Total prudential provisions at the end of 2015 were sufficient to cover over 58 percent of NPLs while the IFRS provisioning ratio stood at 68.94 percent.
- The capitalization of the banking sector stays above 18 percent.
- The NBR will continue to closely monitor and supervise the banking system and take any necessary measures to ensure that banks maintain sufficient capital and liquidity.
- In close coordination with the IMF and EC, the NBR will continue to regularly conduct top-down and bottom-up solvency stress tests as well as liquidity stress tests of the banking industry.
- Emerging systemic risks identified:
  - domestic: risk of an uncertain and unpredictable legislative framework in the financial and banking field (maximum intensity),
  - external: possible exit of the United Kingdom from the European Union (high intensity).

### Structural reforms, SOEs, and business environment
- The government is determined to adopt, as soon as possible, the draft legislation and to pursue a steadfast implementation of reforms aimed at improving corporate governance of SOEs.
- Progress with the implementation of the structural reform agenda continued but experienced limitations.
- Governance problems have received more attention; key challenges include:
  - improving corporate governance of state-owned enterprises,
  - restructuring those that have sustained long-standing problems and pose a drain on the budget,
  - raising EU-funds absorption,
  - improving the investment climate.
- Progress with reform of the administration and improvement of the business environment is necessary and important.
- The efforts made by the authorities were recognized in the 2016 flagship report of the World Bank, Doing Business: Romania is now ranked 37th from previously 48th, especially thanks to achievements in paying taxes, enforcing contracts and improving the insolvency system.
- Authorities aim to:
  - speed up reforms to make public administration more efficient and transparent,
  - further prioritize public investment projects,
  - strengthen targeting of social protection schemes,
  - extend centralized procurement to generate savings,
  - pass the public procurement law.

### Authorities' stance and commitments
- The authorities thank staff for the thorough and constructive discussions during the Article IV mission, and for their valuable advice on macroeconomic policies.
- They remain committed to prudent policies, focusing strategy on:
  - promoting growth,
  - increasing labor participation,
  - improving competitiveness,
  - reducing vulnerabilities.

*Source: _cr16113 - 8.8 percent. The inflation rate had a positive evolution during the last years. Since 2013,*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16113.pdf_